Yuan Drops Most on Record Amid Band Widening Speculation

An employee counts Chinese one-hundred yuan banknotes next to stacked Chinese one-hundred yuan banknotes for a photograph at the Korea Exchange Bank headquarters in Seoul, South Korea. Photographer: SeongJoon Cho/Bloomberg

Feb. 28 (Bloomberg) -- China’s yuan tumbled by the most on
record on speculation the central bank will widen the currency’s
trading band, allowing greater volatility at a time when growth
is slowing in the world’s second-largest economy.

The yuan slid as much as 0.9 percent to a 10-month low of
6.1815 per dollar, the largest decline since China unified
official and market exchange rates in 1994, according to data
compiled by Bloomberg. The currency lost 1.3 percent in
February, the biggest monthly drop on record. Trading in yuan
options surged in New York, making them the most traded
contracts among major currencies.

The People’s Bank of China is expected to double the yuan’s
trading band by the end of June, according to the majority of 29
analysts surveyed by Bloomberg, as policy makers loosen
exchange-rate controls and promote greater usage of the currency
in global trade and finance. Lawmakers will meet next week to
decide on major economic policies and an official report
tomorrow is forecast to show manufacturing expanded this month
at the slowest pace since June.

“China looks determined to proceed with financial reforms,
and so a wider band in the near term looks likely,” said Daniel
Chan, a Hong Kong-based strategist at China Silver Global
Investment Consultant Ltd. “As yuan selling pressure is still
on, a wider band will mean further declines. That’s obviously
among the concerns in the market.”

Options Trading

The yuan ended the day in Shanghai down 0.3 percent to
6.1452 per dollar even as the central bank kept its daily
reference rate steady to 6.1214 per dollar, Bloomberg data show.
The currency is allowed to up to 1 percent on either side of the
central bank’s reference rate. The market rate was 0.4 percent
below the official quote, the biggest discount since August
2012.

More than $14 billion of dollar-yuan options changed hands
as of 11:58 a.m. in New York, accounting for 31 percent of all
option trading among major currencies, according to data
reported by U.S. banks to the Depository Trust Clearing Corp.
The volume reached $31 billion on Feb. 21, compared with a
three-month average of $8 billion.

Goldman Sachs Group Inc. said a combination of
macroeconomic and currency reform objectives are behind the
yuan’s sudden drop, according to a report published yesterday by
analysts including Kamakshya Trivedi in New York. There are
growing concerns over the growth impact of a credit buildup in
the last few years, the report said. Policy makers also want to
discourage leveraged bets on yuan appreciation, especially by
local companies, it said.

PBOC ‘Engineering’

“There are sound reasons why local policy makers would
welcome the kind of depreciation and volatility we have just
seen,” the analysts wrote. “To the extent that policy makers
care to discourage such carry trade activities -- particularly
for local entities -- introducing volatility in the currency is
the obvious way of shaking investors out of such carry
exposures,” they said.

The PBOC is “engineering” the yuan’s slide to deter bets
on one-way appreciation, said Liu Dongliang, a Shenzhen-based
senior analyst at China Merchants Bank Co.

The yuan has declined 1.7 percent from the 20-year high of
6.0406 reached on Jan. 14, according to the China Foreign
Exchange Trade System prices. It is still up 34 percent since a
dollar peg ended in July 2005, the most among 24 emerging-market
currencies tracked by Bloomberg.

In offshore trading in Hong Kong, the yuan fell 0.22
percent today to 6.1199 per dollar, after touching a six-month
low of 6.1336 earlier. It’s slumped 1.4 percent this month, the
most since September 2011.

Twelve-month non-deliverable forwards, which traders use to
speculate on the yuan, fell 0.1 percent to 6.1565 per dollar in
New York, according to data compiled by Bloomberg. The contacts
suggest traders expect the central bank’s reference rate may
fall about 0.6 percent in one year.

The median estimate of analysts surveyed by Bloomberg was
for the rise to gain 2.9 percent to 5.97 per dollar by the end
of 2014.

‘Severity of Moves’

“The severity of moves is surprising the market,” said
Khoon Goh, a Singapore-based strategist at Australia & New
Zealand Banking Group Ltd. “There are not many dollar offers
and any bid is just getting taken, driving the dollar higher
against the yuan.”

The PBOC included an “orderly” broadening of the yuan’s
band among its 2014 policy goals in a Feb. 19 statement, while
the State Administration of Foreign Exchange said on Feb. 26
that two-way moves in the exchange rate will be the norm and
that the market shouldn’t read too much into the recent decline.

Of 29 analysts surveyed by Bloomberg News in the past week,
20 forecast a band widening in the April-June period, while four
said they expected a change in March. The maximum divergence
from the PBOC’s fixing will double to 2 percent in the next
revision, according to 21 of the predictions.

Weakening Bias

The onshore spot rate was 0.97 percent stronger than the
fixing on Jan. 23, before the two converged this week for the
first time since September 2012. The yuan was at a 0.24 percent
discount to the fixing a day before the last widening of the
band, when the maximum allowed divergence was doubled from 0.5
percent. The trading limit was first raised from 0.3 percent in
May 2007.

The yuan’s drop “has likely been caused by markets
interpreting PBOC bias as being toward testing the lower half of
the daily trading band and by speculation that the range may be
widened this weekend ahead of the National People’s Congress
next week,” said Dariusz Kowalczyk, Hong Kong-based strategist
at Credit Agricole CIB.

Implied Volatility

China’s official Purchasing Managers’ Index was probably
50.1 in February, above the 50 mark that divides expansion and
contraction, according to the median estimate in a Bloomberg
survey before data due tomorrow. That would indicate the slowest
manufacturing growth since June. A preliminary reading of PMI by
HSBC and Markit Economics released Feb. 20 fell to a seven-month
low of 48.3, suggesting a contraction.

Three-month implied volatility in the onshore yuan, a
measure of expected moves used to price options, slipped to 2.06
percent today, from a seven-month high of 2.12 percent
yesterday, according to data compiled by Bloomberg.

Increased two-way volatility in the yuan is among the key
steps needed to prepare for a broader trading band, according to
Sacha Tihanyi, a Hong Kong-based strategist at Scotiabank.

“The weakness is policy driven,” said Ju Wang, a Hong
Kong-based currency strategist at HSBC Holdings Plc. “The
problem is that the market is still rather bullish on the yuan
even after a recent selloff. Policy makers want to test the
market further and see visible evidence that speculation has
reduced.”